By William G. (Bill) Stuart
Director of Strategy and Compliance
Aug. 18, 2016
HSA rules allow accountholders to move some funds from other tax-advantaged accounts into their HSAs. These rules give accountholders greater flexibility in managing their overall investment portfolio. They also reinforce the important notion that HSAs are an excellent savings and investment vehicle and should be treated as part of an overall retirement investment strategy rather than as merely a reimbursement account that provides immediate tax benefits.
Let’s review the differences between a rollover and a transfer and the rules around rollovers and transfers between other financial accounts and HSAs.
Rollover vs. Transfer
While these terms are often used interchangeably, rollover is used as a generic term describing any movement of funds between various financial accounts and HSAs. The two terms describe different processes with different pitfalls.
- Rollover: Accountholders request a distribution check from the older HSA administrator and are responsible for re-depositing the funds into the newer HSA within 60 days. If they fail to do so, the entire amount is deemed a distribution for non-eligible expenses. The distribution is included in the accountholders taxable income and subject to an additional 10% tax as a penalty. This notion of taking possession of the funds with a requirement to re-deposit them within 60 days is often dubbed the ‘playing with fire’ rule for obvious reasons – the penalty for failing to re-deposit funds within that time frame results in individuals’ losing up to half the balances they withdraw in taxes and penalties.
- Trustee-to-trustee transfer: Accountholders complete a transfer form (typically the new HSA administrator’s document) and submit it to the former HSA administrator. The two administrators then cooperate to move the funds. This process is identical to its counterpart in the Individual Retirement Arrangement, or IRA, world. Since accountholders don’t take possession of the money, they’re not at risk for potential taxes and penalties.
Rollover or Transfer from Another HSA (or its forerunner, an Archer Medical Savings Account, or MSA)
If you have more than one HSA, you can close one account and move the money into another. Accountholders typically face this situation when they opened an HSA through a former employer and now are participating in an HSA program with a new employer through a different HSA administrator. In nearly every case, employers choose to exercise their option under HSA rules to limit their program to a single HSA administrator whom they choose. While an employer can’t force an employee to open an HSA with a specific HSA administrator, an employer can choose to send contributions (employer as well as employee pre-tax contributions) to only its chosen HSA administrator.
In this case, employees are wise to open an HSA with their employer’s chosen administrator. That way, they can receive employer contributions (not otherwise available) and make pre-tax payroll contributions (otherwise, they can make personal contributions that they can deduct on their personal income tax return, but they and their employer don’t receive a refund on FICA payroll taxes paid).
When opening a new HSA leaves individuals with two active HSAs, they need to weigh the merits of a rollover. Here are three questions that they should ask themselves:
- Do I want to manage multiple HSAs? Owning more than one HSA is permitted, but this involves managing two or more accounts and possibly paying administrative fees on the both accounts. Many accountholders find it advantageous to consolidate into a single HSA.
- Does the older account have a unique feature? An individual may have two HSAs with very different features. The older one may offer more investment options, for example. If the older HSA has features that are important and aren’t offered on the newer HSA, an individual may want to maintain two HSAs.
- Is there an account closure fee? Many HSA administrators impose an account closure fee – often between $20 and $30. An accountholder needs to weigh this fee against the monthly administration fees associated with the account. Tip: Accountholders with two HSAs can make distributions from the older account until they’ve exhausted the balance. The faster they do so, the less they pay in monthly administrative fees.
Transferring balances from an IRA
HSA-eligible individuals are allowed to transfer funds from an IRA to an HSA. An individual who moves money from a traditional IRA (all distributions are taxed as ordinary income) to an HSA (distributions for eligible health-related expenses are tax-free) has an opportunity to see the tax savings and buy more medical, dental and vision care in retirement. For example, an HSA owner who buys a $325 pair of glasses in retirement would have to withdraw $400 from a traditional IRA to buy the glasses and pay taxes on the distribution. The same individual can withdraw $325 from an HSA to pay for the glasses tax-free. For most taxpayers, eligible HSA distributions buy about 20% to 30% more than equal withdrawals from a traditional IRA.
Here are the basic rules:
Individuals must be HSA-eligible at the time of the transfer or rollover.
- Funds must come from one account, and that account must be a traditional or Roth IRA. Accountholders can consolidate multiple IRAs into one and, if permitted under federal tax law, roll other retirement account funds into an IRA. Funds from a SEP IRA, SIMPLE IRA, 401(k), 403(b) and other qualified retirement accounts can’t be rolled over or transferred directly into an HSA.
- Rollovers count against the annual contribution limit ($3,350 in 2016 and $3,400 in 2017 for self-only coverage and $6,750 both years for family coverage), thus reducing accountholders’ ability to reduce taxable income in the year of the rollover or transfer.
- Accountholders can make one rollover per lifetime. Exception: If they make a rollover while covered on a self-only contract and then are eligible to make a family contribution later that same year (typically due to 1 reason: marriage, birth or adoption), they can make a second contribution that tax year up to a total rollover that doesn’t exceed the maximum contribution for a family contract.
- Individuals must remain HSA-eligible through the “testing period” – 12 full months following the month of the rollover. If they lose eligibility for any reason (other than death), the distribution is included in their taxable income and subject to an additional 10% tax.
Individuals who want to move money from an IRA to an HSA can choose either the rollover or trustee-to-trustee method outlined above. For more information, please see IRS Notice 2008-51.
Accountholders thinking about making a one-time rollover from an IRA to an HSA should answer the following questions:
- Is my source of funds a traditional or a Roth IRA? A traditional IRA offers tax-deductible contributions (like an HSA), tax-free accumulation (like an HSA) and distributions taxed as ordinary income. By contrast, HSA distributions for eligible expenses are tax-free. A traditional IRA is an excellent source of rollover funds. By contrast, a Roth IRA features taxable contributions (unlike an HSA’s tax-deductible contributions), tax-free accumulation (like an HSA) and tax-free distributions for all purposes (vs. an HSA’s tax-free distributions for health-related expenses only). Moving funds from a Roth IRA to an HSA actually results in less freedom to make tax-free distributions.
- Do I want to forego a reduction in my taxable income this year? A dollar moved from an IRA to an HSA reduces by a dollar the contribution the individual can make to reduce this year’s taxable income. If the individual is sold on the idea of moving funds, they may want to do so in a year that they face a lower federal marginal income tax rate (typically due to not working part of the year, one-time deductions that reduce taxable income dramatically) to reduce this disadvantage.
- Do I need immediate cash to pay a large bill (and is my IRA the right source of that cash)? An accountholder can fund an HSA quickly by moving funds from an IRA to an HSA. The advantage is cash flow. The disadvantage is that they spend a retirement asset, which is no longer available in their later years.
- If I plan to save and invest the rollover amount in my HSA, do I have the tools or discipline to save and not spend? Some accountholders open a second HSA for savings and investment. That way, they’re not tempted to fund this year’s HSA at an amount below their out-of-pocket expenses and consume part of the balance. Others are disciplined enough, or have tools available with their account, to minimize this potential wealth-buster. Most financial advisors counsel their clients not to “eat the seed” by spending today money that will grow for years to create a more secure retirement.
- Will I have the same investment opportunities in the HSA that I have in my IRA? Many IRAs offer a broader menu of investment options than their HSA counterparts, which may impact account growth. HSA accountholders should be sure not to overlook this important HSA feature when deciding whether to move funds from an IRA to an HSA.
Rollovers from a Health FSA or HRA
Federal tax law doesn’t allow individuals to roll over unused balances from a Health FSA or a Health Reimbursement Arrangement (HRA) to an HSA. (They were allowed briefly between 2007 and 2012, though the rules were written in such a way that few accountholders were able to take advantage of the provision.)
What we’re reading
How much is the lack of health literacy contributing to total health care costs? The figure may be staggering. A column in Forbes magazine illustrates some examples and provides some sound suggestions for patients as they become more involved in the medical and financial implications of their health and care.
You may have heard Democratic presidential nominee talk about the “public option.” This term refers to medical coverage offered by the federal government in direct competition with private insurers. While many economists see the unfair advantage that the government would have in the marketplace, John Graham of the National Center for Policy Analysis argues that private insurers should embrace the public option for selfish reasons, even if it’s a bad idea for taxpayers. Read his analysis here.
What will it take to provide better information for health care consumers to evaluate the cost and effectiveness of treatment options? Perhaps the Right to Shop. Josh Archambault and Nic Horton explain in Forbes magazine’s The Apothecary here.